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Demography as Destiny

Josh Brown had an interesting post yesterday based upon a report from Tobias Levkovich of Citi (Bloomberg story here) focusing on the anticipated boom in 35- to 39-year-olds — those in their key “savings years.” This age group is said to be poised to increase for the next 17 years. Saving and investing by these echo boomers “would generate a new set of equity fund inflows,” Levkovich claims. Levkovich expects the S&P 500 to rise to 1,615 in 2013, about 50 points higher than the index’s October 2007 record and about 12 percent above current levels. Besides demographics, he argues that expansion in U.S. manufacturing, energy, mobile technology and housing and efforts to curb federal budget deficits will combine to drive stocks higher. He also sees valuations as attractive.

Obviously, Levkovich is generally paid to be bullish, so his forecast needs to be considered in that light. But still, I hope he’s right. However, I’m not sold on the growing strength of the economy, anything other than ongoing governmental dysfunction (seehere and here, for example) or attractive valuations — even though I could easily be wrong. I’m also skeptical of his view of the demographics.

The ongoing demography as destiny argument is a fascinating one. A useful paper called Demography and the Long-Run Predictability of the Stock Market back in 2002 argued that P/E ratios are correlated to the ratio of middle-aged people to young adults (the “MY ratio”). When MY rises, the market P/E will tend to rise and when it falls, P/Es tend to fall. This study claimed that we should see a continued fall in P/E ratios from then (2002) through and until a long-term bottom in stock prices forming about 2018. So by that measure, Levkovich is about five years early. It may be hard to imagine a Wall Street analyst being too bullish too soon, but there you go.

On the other hand, a report on Boomer retirement and demand for stocks by researchers from the Federal Reserve Bank of San Francisco got a fair amount of play about a year ago and came to a different conclusion. The full report is available here. They see a strong relationship between the age distribution of the U.S. population and stock market performance too. But they see the aging of the baby boom generation as the key demographic. As Boomers reach retirement age, they are seen as likely to shift from buying stocks to selling their equity holdings to finance retirement. They report that their statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades.

A helpful discussion of the methodological differences between the papers cited above by Cam Hui is available here. Hui’s analysis also carefully notes that the differences between the respective findings are not all that great. The San Francisco Fed researchers concluded that stock prices will bottom in 2021, instead of 2018 as implied by the other paper cited above. That’s not much more than a rounding error for this types of analysis.

On the other hand (although, like Tevye in Fiddler on the Roof, there is no other hand), a Congressional Budget Office background paper published in 2009 comes to a different conclusion from that offered by the San Francisco Fed researchers. The CBO paper argues that Boomers won’t sell assets very rapidly to finance retirement on account of several factors.

Boomers will be careful — they are concerned that they might live longer than expected or might face higher than anticipated medical costs.

Boomers desire to transfer assets to the next generation, which should also blunt asset sales.

Since the wealthiest one percent of Americans own about one-third of the nation’s financial assets and, for the most part, the very wealthy don’t sell assets to finance retirement, this asset concentration will help to keep demand steady.

Many Boomers may work longer than they otherwise would have due to losses of retirement assets due to the 2008-09 financial crisis (but the empirical evidence on this point is inconclusive and the impact might be small).

Wharton’s Jeremy Siegel, author of Stocks for the Long Run, says (unsurprisingly) that growth in developing countries should generate enough demand to absorb a baby-boomer selloff and “keep stock prices high.”

The CBO conclusion may be the key one in this context.

Although the retirement of the baby boomers is not likely to cause a large decline in aggregate demand for assets, several economic studies suggest that the retirement and aging of baby boomers could cause a temporary decrease in asset prices. … Empirical evidence, however, has not revealed much connection between demographic trends and the changes observed in financial markets.

Demographics surely matter. Correlations are important (even if distinctly different from causation). But so do lots of other things — like (duh) the strength of the economy or lack thereof and market valuations. The market did not tank in 2000 on account of demographics and demographics isn’t controlling the nature and extent of this secular bear market even if and as it is a noteworthy factor. Demographic trends are interesting, useful and important for the markets. But there is no evidence that demographics is destiny.